Warehouse Receipts and Collateral
Management
Presentation to FICCI
New Delhi
17th July 2004
Agenda
Current Status of
Warehouse receipts
Issues before Lenders
Exchange physical settlements
‘Collateral Management’ concept
Role and Functions of Collateral manager
Risks and mitigants
Efficient commodity markets
Multiple buyers and multiple sellers
Price discovery platform
Price dissemination
Transparent clearing and reliable settlement
Spot and Futures markets
Commodity based credit
Commodity based tradable warrants
Essential elements for efficient post-harvest markets
Commodity based finance and warrants
Policy environment
Market information support
Recognition of trader
State as facilitator and regulator
Stable and low interest rates
No controls on stocking, movement and prices
Legal framework
Contractual rights of parties protected
Facilitate trading in warehouse receipts
Enablers by and large in place
Commodity based finance and warrants
Institutional framework
Sound banking system
Futures exchanges
Price stability
Network of warehouses
Collateral Managers
The concern is on warehouses and collateral managers
Warehouse receipt
Document stating the ownership of commodity
Specified quantity, quality and grade
Warehouse location , storage fee etc.
Can be sold or used to raise a loan
Used for delivery against a derivative instrument
like futures contract
Converts agricultural produce or other inventory to
a tradable warrant
Legal status of warehouse receipt
Conventionally accepted as a ‘document of title’
Transferability contingent on terms and
conditions of issuer or by law
Generally issued as transferable receipt
Not a bearer instrument
Need endorsement for transferring the rights
Notice of endorsement need to be submitted to
warehouse
Non-negotiable instrument
Limited usage in India; conventionally low status even
in comparison to B/L, AWB, R/R and L/R
Key issues in current warehouse receipt structure
Warehouse receipt not a negotiable instrument in
India
Transfer of title is possible with endorsement
But title not free from any outstanding claims
Weakens its status as a ‘security interest’
Low credibility of the ‘warehouse' issuing the receipt
No independent warehouse accreditation body
Lack of
Performance guarantees and reliable insurance cover
Confidence in quantity and quality of underlying
commodity
Credibility of warehouse receipt needs to be enhanced
Prerequisites for negotiability status
Grading standards for commodities
Market’s confidence in the warehouse operators
Independent approval or accreditation
Insurance and performance guarantee
External supervision and monitoring
Confidence in quality and quantity of stock
Circulation of genuine receipts
Easy transferability of commodity ownership
Electronic holding of commodity balances
Collateral Manager as an independent and expert third party?
Key enablers for warehouse receipts
Negotiability status of the warehouse receipt
Collateral management services
Grading, quality, quantity and weight controls of the
underlying physical commodity
Process controls at the warehouse
Insurance, legal and financial structures
Protection of the marketable value of the collateral
Secure electronic warehouse receipt system
Mitigates the risk of physical tampering
More checks enabled by the multiple parties
Commodity information secure with depository
Warehouse receipt system with Collateral
manager
Deposit commodities
Farmer/ Trader Bank Finance
Farmer/ Trader
Warehouse 1
Warehouse 1
Warehouse
Deposit receipt
Collateral Manager
Collateral Manager
commodities
Lender
Lender
22 33 44 55
Warehouse
receipt
Commodity Exchange
Commodity Exchange
Currently Rs 70 bn exposure by lenders as against annual agro
commodity size of Rs 11,000 bn
Indian Collateral Management Spectrum
Clients Vendors
Warehouses
Lenders Transporters
Logistics players
Commodity C & F agents
exchanges
Grading , assaying
Farmers & Certifying firms State
Traders Management
Collateral Warehouse
Accrediting Agency
Processors Procurement
Depository Agency Agencies
Distributors
Exporters DPs and R & T agents Marketing
Agencies
Importers
Why banks do not lend against commodities
?
Price risk - no mechanism for hedging
commodity price
Credit risk - inadequate structures to transfer
risk from borrower to commodity
Operational risk – poor state of warehouse
management process and control on collateral
Inadequate and irregular MIS on stock
holdings
Curtailed lending against warehoused commodity- limited
credit flow to agriculture
How Lenders manage collateral?
Bilateral arrangement
No third party guarantees
Ineffective stock verification
Lack of control on funds and material flows
No control over logistics
No disposal plan
Risks and concerns for Lenders
Lower credit rating of assets
Larger capital adequacy
Impaired assets – even where credit risk is not
the issue
90 day NPA norm makes the going tougher
Curtailed credit flow for borrowers – especially
SME and Agro sectors
Non fulfillment of sectoral lending
Present task of NCDEX in physical delivery
Specify/evolve commodity specific norms for
accrediting warehouses
Accredit the warehouses in each delivery center
Enter into agreement with diff. WH at different
delivery centers
Arrange quality certifiers and assayers to verify
the compliance of contract specifications at the
time of deposit
Notify the accreditation of the ware house formally.
Periodical Monitoring
Not core functions of Exchange
but essential to facilitate physical delivery
Warehouse accreditation norms
Financial soundness
Positive net worth of minimum Rs. 1 crore
Sound management practices
Technical parameters
construction as per BIS / FCI stipulations
Accessibility – free access by road and/or rail
Least affected by natural calamities
flood, landslide etc.
Availability of requisite labour and other facilities
weigh bridges, packing facilities etc.
NCDEX physical settlements
The Exchange offers trade on 12 agricultural
commodities apart from gold and silver
Around 10 new commodities under consideration
Recent contracts with the feature of ‘seller’s
option’
More physical deliveries expected
multiple contracts at multiple centers
More deliveries likely to boost Exchange volumes
Robust and large scale arrangements required
Over the next 2-3 years, Exchange would need access to
around 500-600 warehouses
Drawbacks
With expanding volumes, the Exchange is
increasingly required to :
Ensure adequate accredited warehouse space
No commitment charges paid
Ensure availability of timely service of assaying and
quality certifying agencies
Ensure coordination of the multiple logistics
providers
Ensure tracking of commodity quality, quantity and
weight
Undertake accreditation of the multiple agencies
Drawbacks lead to operational risks which
need to be mitigated
Concept of Collateral Management
Collateral is an asset or a third-party commitment
accepted by the collateral taker to secure an
obligation of the collateral provider.
“Collateral” has the same meaning as “security”
Used to avoid confusion with stocks, shares, etc.
Transaction intended to protect against
performance risk of counter party.
Collateral Management involves managing the
collateral on behalf of the collateral taker
Global Scenario
Large role in cross-border movement and trade
of commodities
Specialize in servicing mortgage loan
requirements as well as financial collateral
Valued high where the infrastructure is poor and
regulatory monitoring and compliance are
wanting
Enable warehouse receipt financing by
mitigating operational risks and upgrading credit
rating
Proposed role of Collateral Manager in the
Indian context
Ensures adequate accredited warehousing space
Ensures quality and quantity of warehoused
goods
Backs the same with guarantees and insurance
Provides in-bound and outbound logistics
support
Advisory and Inventory Management services
Provides on-line and accurate reporting
Facilitates disposal of collateral, when necessary
End-to-end collateral risk management solutions and
services for lenders, commodity exchanges and others
Functions and responsibilities of a
Collateral Manager
Identification of potential risks and its mitigants
Due diligence to set up a secure structure
Accreditation / grading of warehouses
Technical specifications & Financial evaluation
Provision of warehousing space
Producers/Traders/Processors, commodity
exchanges
Empanelment of graders / certifiers
Farm-gate to FOB handling services
Facilitating structures for commodity lending
Electronic systems for control and monitoring
Arranging of 24/7 security
Insurance tie-ups and adequate liability coverage
Collateral manager- benefits
Clients
Expands the credit portfolio based on
warehoused commodities / materials
Lenders Mitigates operational risk in credit
Commodity decisions
exchanges
Throws up early warning signals on the
Farmers banker’s screen
Traders Losses can be controlled at an early
stage
Processors
Enhances portfolio credit rating
Distributors Enables bankers to focus on financials
Exporters and credit risk rather than logistics
Importers
Lender’s concerns addressed
Price risk
Hedge price risk on commodity exchanges
Credit risk
Collateral manager assist in effective credit risk
management and due diligence
Operational/Performance risks
Offloaded to the professional Collateral Manager
Legal / litigation risks
Reduced ; Collateral Manager ensures proper
documentation, adequate insurance cover etc.
Structured Commodity Based Financing
Structured form of financing with the objective of
transferring risk from entity to a commodity
Soya loans; CPO loans
Secured exposure on borrowing entity wherein
security is commodity
Borrower Borrower risk
Collateral
manager
Finance
Commodity
Lender can hedge his
price risk on NCDEX
Commodity risk
Lender
CBF will imply greater finance for the borrower and less risk to bank
Advantages of CBF + CM
Raw material prices are locked thereby hedging
risks
Leverage on raw material as the primary
collateral
Attractive pricing through structuring
Financing in convenient tranches
Aligned with the stock build-up schedule
Can be structured as off-balance sheet funding
Collateral manager-benefits
Clients
Increase in physical deliveries
Wider participation by growers and
Lenders processors
Commodity One stop service to mitigate operational
exchanges risks
Farmers Spot trading and deliveries enabled
Traders
Access to markets and better infrastructure
Processors Reliance on market mechanism-reduced
dependence on government
Distributors
Better price, staying power and lower
Exporters borrowing costs
Importers
Finance readily available at lower cost
Larger level of operations
Collateral manager-benefits
Clients
Improved supply chain
Lenders Quality, quantity and weight checks
Commodity Inventory / commodity based
exchanges
borrowing at better terms
Farmers
Inbound and outbound logistics
Traders
support
Processors Improved MIS - better inventory
management
Distributors
Domestic and overseas logistics
Exporters
Better coverage of insurable risks
Importers
Risks and mitigants for the Collateral
Manager
Legal backing to accreditation
Work with reputed rating agencies
Negotiability of Warehouse receipts
Law under drafting
Electronic holding of balances
Operational risk management in rating enhancement
structures
Monitoring and inspection mechanism
Pioneering concept- market acceptance
Need for lenders and exchanges to expand business
New concept- hard selling needed
Credibility to be built up from the ground
National Collateral Management Services Limited
(NCMSL)
The first national level Collateral Management
company to be set up in India
Confirmed institutional promoters:
NCDEX
Audit Control & Expertise (ACE)
ICICI Bank
Canara Bank
Corporation Bank
Punjab National Bank
Other interested institutions :
Indian Farmers Fertilizer Co-operative Limited (IFFCO)
HDFC Bank
Provide end to end collateral risk management solutions
Looking Ahead
Current lending against commodities by Indian
commercial banks is just Rs 70 bn
Expected to grow 5-7 fold over next 3 years
Technology and risk mitigants – key enablers
Emerging investment diversification
Next perceived boom after retail lending
Thank You